Tuesday, December 27, 2011

My Forecasts for 2012

Since it is only a couple days after Christmas I thought I might try something a little different in the blog this time.  All of you are probably still in the giving spirit or in the spirits. So there is no sense in me trying to be too analytical. Many of you are already sick of shopping and you have returned most of your gifts to Walmart so you are open for diversion. Those of you with visiting relatives are posting signs on your refrigerator that indicate that fish and visitors begin to smell after three days.

But this is a MACRO blog and I can’t just blather on about post-Christmas blahs. So what I am going to do is provide you with my forecasts for 2012.

First Peyton Manning will overcome his neck injury and will star with Kim Kardashian in a new reality TV show about the art of hiking a football. I won’t say who will play center but some of you wise guys have already figured it out.

Second, the Indiana University Football Team will win the conference championship in 2012 but will not be bowl-eligible because high school conference winners are not allowed to compete at the university level.

Third, the US election in 2012 will be won by David Letterman. He will run on the Funny Party Ticket arguing that the current batch of DC politicians are not funny and he is.

Fourth, the euro currency will go out of use and will be replaced by the Hungarian forint.

Fifth, Andra Klemkosky will replace Robert Klemkosky as the Dean of Business at SungKyunKwan University in Seoul.

Sixth, small business owners will be given a new Eli Lilly growth hormone so they are not so small.

Seventh, with the FDA closed for roof repair, any drug having gone through testing by movie stars at the Betty Ford Clinic will be approved and available for immediate sale at whatever price the market will bear.

Eighth, Pharmaceutical companies,  Cook Medical, the Post Office, and Topless Bars in DC will become government enterprises managed jointly by Kim Jung Un and the Donald.

Ninth, Vietnam, North Korea, Sanibel Island, and Ireland will become the 59th and 60th states of the USA.

Tenth, US rich people will be asked to move to Nova Scotia and Latvia but will be required to send their pay checks to President Letterman.

Eleventh, poverty status will be extended to all remaining US citizens so there will be no need for anyone to have to work or even pretend to work. The unemployment rate, therefore, will fall to zero percent, the lowest level in 362 years, guaranteeing re-election of the Letterman /Bashar al-Assad ticket.

Twelfth, world GDP will be equal to this year’s plus or minus.

Thirteenth, I cannot remember where I left my car keys and the 13th thing.

I hope you are having a great holiday with lots of spirits and whatever else your usual holiday rituals might dictate. Please do not harm your relatives because some of them might be planning to leave you money. I look forward to bringing you more Macrocrapola in the New Year. 

Tuesday, December 20, 2011

Don’t Open that Gift if from Obama, Reid and Boehner!

The political debate in the USA over the extension of payroll tax cuts and the unemployment benefits (Extensions) is as hot as it is wrong-headed. It’s like two caged female dogs in heat. They both have incredible passion but they have no real ability to make the transaction work. Please no angry letters from dog lovers or my lesbian relatives and friends. No insult is intended.

Anyway, this Extensions fiasco reveals what is so wrong with politics now. Consider first that both parties seem to agree that the extensions are necessary.  They disagree about how to pay for them but they seem to say over and over and over and over and over – getting irritated? – and over that they want to extend the cuts but the extensions must be paid for. The guys wearing stripes think the rich should pay for them while the guys in the polka dots believe it has to come out of other spending.

Like the two dogs in heat, this dog won’t hunt. That’s not the metaphor I was after but I think you know what I mean.  Both sides seem to agree that without these extensions, the US economy is going to go careening off the ends of the earth.  Like driving on the right and eating foot-long chili dogs with ROC-CO-COLA, one cannot question the validity of this truth.  Either we do the EXTENSIONS or the US economy is going to slide head-first into the outer atmosphere.

But we do drive on the left on one-way streets and we sometimes eat foot-long Philadelphia Steak and Cheese sandwiches, so it might be possible to think a teeny-weeny little bit about what might happen if we did not do the extensions. Will the US really slide off the planet? First and foremost it is possible that if we did not make these extensions we would find that US government and other bonds would increase in value. The very thought of increasing government spending right now in a time of huge government deficits could be taken as another sign that the US government cannot govern. This would be true whether or not we enact means to pay for these Extensions. Notice where we are today. It is not yesterday it is today. Today we have failed yet another time to do anything about a solution for government debt and deficits. We can't even find a solution for next year's budget. Not only did the special committee not come to a decision, but now we are being told that the so-called automatic cuts are going to be undone. So let’s be honest here—in financial terms we are looking like the guy who applies for his tenth credit card after maxing out the other nine.

Okay – it’s just another $100 billion or so. To some it seems like nothing. But they are living in yesterday. Yesterday was when love was such an easy game to play. Now I need a place to hide away. Oh yesterday came suddenly. Anyway, the Beatles were right-on in many ways. $110 billion three years ago might have been okay. But now we are on our 10th credit card. Pass these extensions with or without a tax on the rich and the credit markets are going to chew up our bonds and precious dollar as if they were a male dog coming between those females in heat.

What that means is that interest rates will soar, net worth will decline, and spending will come to a halt. Some of you will say it is worth taking the risk. You will say that by not doing the Extensions we have two major sure-thing problems – the average family will lose income per month and those families will curtail their spending. You will conclude that stopping the extensions, then, is both unfair to the average family and will lead to reductions in national spending.

But let’s put these two points together. Let’s suppose that the average family understands that when financial markets look down their collective snoot at the US demand for a 10th credit card, all hell will break out. Let’s suppose this makes the average employed or unemployed worker worry even more worried about the economy. I am guessing that those workers will not readily part with their extension money. They will become even more judicious about how they spend because they need to make sure they continue to have some spending power in the future – as this stupid economic policy makes sure the economy stays weak for a long, long time. Notice that the extension plan does two things – (1) it initially gives more income to some Americans but they will prudently reduce their spending anyway; and (2) it creates a gigantic financial disturbance that will reduce even more spending by all Americans.

So call me insensitive if you want. But the fact that both parties are saying we need these Extensions is exactly the reason you should believe we don’t. Do you really believe these guys? They are continuing to do what they have been doing for years --- avoid the real solutions and pander to people who they think are easily fooled – you and me. Can you imagine what you will get when a smiling trio of Obama, Reed, and Boehner hand you your Christmas gift. I suggest you leave it on the ground and run like hell!

It seems to me that we would all be better-off without this cut...or more succinctly, without this cut in isolation. What we really need is an overall solution for the debt/deficit/growth issues. The special committee failed but Congress could do it tomorrow. Part of that overall solution could include these Extensions but in a responsible fashion whose goal is to deal with deficit/debt/growth.

Tuesday, December 13, 2011

GUEST BLOGGER: Lies, Damn Lies and Occupy Wall Street—Charles Trzcinka

Charles Trzcinka is the James W. & Virginia E. Cozad Chair in Finance at the IU Kelley School of Business

In all the discussion about the tactics of the OWS movement there has not been much attention on what the movement believes about the economy.  The purpose of this memo is to provide students with facts, analysis and a guide to sources of information to help evaluate the claims of the OWS movement. From the title you can see my opinion—the OWS assertions are just anti-establishment babble. I strongly believe that a career choice in finance is both socially useful, moral and clearly remunerative.

Investment Banks are Bad
If any opinion is clear, it is that OWS do not like investment banks. It is not clear what they would do differently. Investment banks help companies raise capital to create jobs. Countries without this ability are poor and the poor in these countries are destitute relative to the United States. How else will savings get to companies who need to invest?  During the 20th century many countries attempted to severely restrict investment banking by government ownership of firms. The result was large scale poverty. There a many studies examining this and for a nice overview read:  Saving Capitalism from the Capitalists: Unleashing the Power of Financial Markets to Create Wealth and Spread Opportunity by Raghuram Rajan and Luigi Zingales.

Banks Caused the Crash of 2008
Wrong again. The crash was caused by the fall in housing prices. Some banks took big risks with securitization and made the situation worse but the crash also happened in countries where the banks did not take the risks such as Canada and China.  There have been many books written about the crash. For a review of 21 books (10 by academics and 11 by journalists) see http://www.argentumlux.org/documents/Lo__2011__-_Reading_About_the_Financial_Crisis__JEL_.pdf

The article describes some facts that would make the OWS crowd uncomfortable:
·         There were higher levels of leverage in 1998 than 2006 for Goldman Sachs, Merrill Lynch, and Lehman Brothers.   In 2006 the compensation of the top 95 bank CEO was almost all concentrated  in stocks and options which means that the CEO stood to lose the most personally by any risk-taking and they did lose. 

Bank Bailout hurt the common person
This is not close to true. The bailout was about $250 billion and was mostly paid back. The Obama administration claims that the taxpayers have already made $20 billion on this deal. That is, the administration is bragging about its investment. You can see a report by the General Accounting Office that more or less supports this (www.gao.gov). It’s worth noting that the Tea Party movement also made this claim and they were also wrong.

Corporate Greed Causes Poverty
It’s often shouted that corporate greed is causing the income distribution to be skewed to the rich, commonly defined as the top 1% of the income distribution. The claim ignores the fact that corporations have been seeking profits for over 200 years. They are not more profit –seeking today than they were 50 years ago when the income distribution was much flatter.

Corporate Greed is immoral
The OWS movement is constantly asserting that the profit motive is immoral. To me this is a perversion of Judeo-Christian values since capitalism is by far the best system for raising the income of everyone. For a mainstream argument, you could look at Michael Novak, a leading Catholic social theorist, who has written widely on the morality of democratic capitalism - and advocated a moral-cultural system that would nourish the values and virtues on which free societies depend. "Three in One: Essays on Democratic Capitalism" introduces his basic ideas. The point is simple: if we want to increase human welfare this is no better way than the market system.

The Income Distribution is the widest its ever been
This is another distortion -lie. Here is a graph from Paul Krugman. The 1% is increasing but is not yet close to the “gilded age” 

(Note from Larry -- I could not insert the diagram. Sorry. It shows the share of the top 1% was much higher than now until about 1940. The share declined and then began to rise. Chuck gives you a link below where you can draw income share graphs for many countries from the early 20th century through 2008.)

You can generate more plots like this at (http://g-mond.parisschoolofeconomics.eu/topincomes/).  You find a similar U-shaped pattern in Australia, Canada, Ireland, and New Zealand but less so in France, Germany, Japan, and Sweden. The rising tide started during the Carter administration and continued through Reagan, Bush, Clinton, Bush and Obama. It is worldwide and hardly due to US policy. It appears to be strongly related to education.
Finally it is worth noting that the “99%” has also gained in the past 10-20 years just not enough to satisfy the OWS crowd.

Wall Street Controls Politics with its money
This is simply wrong. Nobody has ever found a reliable relationship between political contributions and policy. Most conclude that campaign spending has a very small effect on election outcomes regardless of who does the spending. (For example see Stephen Levitt’s Using Repeat Challengers to Estimate the Effect of Campaign Spending on Election Outcomes in the U.S. House." Journal of Political Economy, 1994, 102(4), pp. 777-98. ). There are of course examples of how money twisted some policy but for every such example there are plenty of examples of political contributors who wasted their money.  The OWS movement appears to believe that because people have money and because some of them make big contributions that politics is corrupted by money. But this is like arguing that because companies spend money on advertising, it must be effective. It is not. Most advertising expenditures are wasted because it’s so hard to predict which will be effective. Political contributions are for the most part simply wasted and there is plenty of money on both sides of most issues.

Challenges for Capitalism
The OWS movement appears to believe that the 2008 global financial crisis marks the beginning of the end of modern capitalism. It is a strange belief because it presumes that there is a viable replacement waiting in the wings. The truth is that, for now at least, the only serious alternatives to today’s dominant Anglo-American paradigm are other forms of capitalism. But there are challenges to market economies. See for example an essay by  Kenneth Rogoff (http://www.project-syndicate.org/commentary/rogoff87/English)

Rogoff points to five serious challenges currently facing modern capitalism: a failure to price public goods (clean air, water, etc.) effectively, high levels of inequality, “the provision and distribution of medical care,” the undervaluing of “the welfare of unborn generations” and, finally, financial crises. Rogoff points out that economics has solutions these problems, if politicians dare to implement them:

On being a finance major
Your choice to be a finance major puts you at the heart of these challenges. Congratulations on having the insight, intelligence and now the courage to do so.

Tuesday, December 6, 2011

Good Policy and Employment Growth in the USA

Hey Pete isn’t it a pity that you can’t run the mile in eight minutes.  Yes, Pete said, but I am happy to be walking after that hip operation last month.  But the surgeon said you would be as good as new in a couple of weeks. Yes, and the surgeon needed a new hot tub cover too. Anyway, despite worries that the US economy is not improving fast enough to bring us back to normal, the Labor Department release last Friday was heartening and suggests further improvement. The payroll survey revised upward job growth in October and reported an increase in jobs for November of 120,000. The companion and broader household employment survey showed employment growing by 278,000 jobs. The unemployment rate fell below 9% to 8.6% as well.

In terms of the overall economy, this is a bit like Pete being able to walk a mile but it is still a ways from his normal mile run. The real issue today is one of false expectations. Activist politicians and economists wanted us all to believe that that their hocus pocus policies would have us running faster much quicker than was really possible. They are just now admitting that the global crisis was larger and deeper than first described – and will take longer than normal to heal.  So while we won’t do a back flip over the recent report, the truth is that the US economy seems to be on the mend.

One of my colleagues – let’s call him Joe since that is actually his name – pointed out to me as I was busting a gut trying to do three consecutive push-ups at the gym – that Europe was at it again. All the news last week was about a possible new compromise that would save the euro, Europe, and seals. But Joe pointed out that every time the EU seems on the verge of an agreement, Merkel and Sarkozy once again decide they are going to re-enact the economic equivalent to World War II.  Merkel wants Europeans to behave more like the Swiss – Sarkozy wants them to act more like Zorba.  Maybe Merkozy could come together and agree that Europeans should act more like the Dutch.  The Dutch are very conservative, save parts of their paychecks each month, smoke dope in Turtle Bars, and generally enjoy life as they ride around the town square on 300 pound 25 year-old bicycles that were given to them by their grandparents. They also say things like Als tublieft and debankt.

Before I go much farther I just wanted to tell you that I have not had sex with any sports coaches or Herman Cain. I do recall several times in high school when my coach said that if I didn’t play better he was going to put his size 16 High Top Converse All Star up my youknowwhat. But that is the closest I came to sex with coaches or politicians.

Financial markets want to see real solutions to our global financial problems. It seems worth thinking about that if the EU and the US were to fashion reasonable compromises that these markets would  be utterly delighted and increase further, consumers would feel wealthier, banking bottlenecks would be relieved, and the world economy could get back to an 8 minute mile. If I was a US politician up for re-election next year I would think about the political payoff to finding a real solution. The payoff to good policy choices has never been stronger. I would worry a lot, however, that if the EU actually does fashion a decent compromise while US government officials continue to approximate the monkey cage at the zoo, the political cost could be quite heavy. Our politicians will look even dumber than the monkeys if they are the only ones to let the milk spoil.

I keep saying words like – real solution.  It is possible that the Europeans and US politicians might come to some agreement or compromise that was not a real solution – and I am NOT advocating that. The room for real solutions, however, is quite ample. For those nuts who read me regularly, you may find this next part redundant but a compromise does not necessarily mean we sell our souls to Bobby Knight. A compromise recognizes that you cannot get exactly what you want but you do not have to give up on your basic principles. It is sort of like me when I agree to participate in our household’s Christmas decoration activities. As a relative to the famous Grinch and the son of two unreligious Jews, I don’t love the idea of spending hours putting together manger scenes, Christmas villages, and lifting a 900 pounds Santa out of the basement. But I do it anyway because I know two things. First, Betty will buy me some really nice Christmas presents. Second, my kids will buy me expensive bourbon.  So it is a good compromise.

A reasonable fiscal package in the US would recognize that housing and finance are the source of our current problems and need to be addressed. This  would entail dealing with the housing default overhang in a way that recognizes the difference between those who might realistically be able to repay with some contract adjustment – and those who might be able to repay but only if they won the top prize in the lottery. A real solution would also put us on a path toward smaller debts and deficits though recognizing that stimulus cannot be withdrawn too fast. A plan to begin reducing government stimulus but at a pace that accelerates over time could be designed by economists.  Should the US Congress come up with something that seriously addresses these two issues, incumbents could laugh their way back to their usual payola and corruption in 2012.

In summary, things in the USA are not as alarming as some people say but are not as good as they could be. We are on the mend from a serious illness but we need to keep following the doctor’s orders. The time for alarm and extreme policies has passed. Even small changes in the right direction can and will have great impacts on wealth, confidence, economic growth and employment. Politicians have much to gain by doing the right things. They do not realize how much they will personally lose if they continue to fritter away time and voter patience.